Inflation Poised to Accelerate

April 18, 2013

Following the financial collapse of 2007-2008 and the Great Recession, the Federal Reserve lowered interest rates to increase liquidity in the economy. Manipulating the interest rate and money supply are just a few of the many tools the Federal Reserve uses in its overall macroeconomic policy to encourage a recovery. Recently, there are numerous signs that inflation is on the rise, say Julie Zhu and Steven Cunningham of the American Institute for Economic Research (AIER).

According to the AIER's Everyday Price Index (EPI), the prices of frequently purchased goods and services jumped 2.3 percent in February, which is more than 25 percent on an annualized basis.

The EPI measure uses the Bureau of Labor Statistics data to measure the prices of day-to-day purchases such as food and fuel, while the more common Consumer Price Index measure includes major purchases such as cars and mortgages.

Over the last decade, the EPI has risen more quickly than the CPI.

The majority of the rise in February's EPI was due to fuel prices, which rose 9.9 percent alone. Luckily, the rise will slow as refineries come back online and prices return to longer-term price trends. Because motor fuel and transportation make up about 20 percent of the average consumer's everyday expenses, the EPI is more vulnerable to the volatility of fuel prices.

Food prices, which make up 38 percent of the average consumer's everyday expenses, remained constant in February at a time in the year when the price of food usually lowers as crops come to market.

Wholesale prices are also posting an upward trend and bond market investors are starting to demand higher interest rates to hedge against inflation for longer term bonds.

The Producer Price Index, which means the prices for finished goods and is a good predictor of rising costs at earlier points in the production cycle, rose by 0.7 percent in February.

In response to inflationary pressures, the Federal Reserve has been expanding the monetary base -- bank reserves and currency -- in hopes of expanding the M2 money supply (currency, checking accounts and savings accounts), the growth of which has slowed in the last six months and could tighten credit conditions, contract the economy and start a recession.

Coupled with inflation in foreign exchange markets, the rising food, gas and wholesale prices indicate that inflation may be increasing.